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Scholar Spotlight: Roger Blair’s Work on Vertical Integration

· November 26, 2019

Research and scholarship are a cornerstone of antitrust policy. They are often the foundation for changes in antitrust law. These changes usually fall into two categories. Scholarship may support opinions that strengthen enforcement so that it reaches conduct that has been shown to be more harmful than previously understood. Scholarship may also show unintended consequences of current enforcement practices, which result in counterproductive or nonsensical outcomes. Because of these trends, some tend to think that antitrust scholars are generally either pro- or anti-enforcement. But this is an oversimplification. Many scholars are pragmatic and can support policies in either direction depending on where their research leads.

University of Florida economics professor Roger Blair has been a pioneer in antitrust policy. He is perhaps most known for his work on monopsony with fellow University of Florida professor Jeffrey Harrison. They steadily built the case that monopsony power was prevalent, worthy of attention, and a violation of antitrust laws. Blair also pointed out that monopsony had been neglected, which was unfortunate because of the risk that judges would believe the conduct unharmful because it tends to lower prices. Blair showed how that thinking was wrong, and how monopsony deserved just as much enforcement as monopoly. Blair’s work was eventually cited in the important Weyerhaeuser v. Ross-Simmons Hardwood Lumber Supreme Court case, which established that monopsony is a mirror image to monopoly and requires similar treatment. Blair’s work on monopsony is likely responsible for today’s moment in monopsony enforcement, where there is enforcement in monopsony labor issues like no-poach agreements.

Monopsony isn’t the only time Professor Blair was instrumental in changing the law. As FTC Commissioner Christine Wilson highlighted in a recent speech, Blair’s work on vertical integration pushed the law towards what many consider a more rational direction. Blair made the case that different types of vertical conduct should be treated the same and analyzed under the rule of reason. Blair’s argument was that the economic effects of these different types of vertical conduct are equivalent, and treating them differently would cause companies to arbitrarily choose some methods of vertical integration over others even if the method they choose is far more costly.

Professor Blair made, and arguably won, this argument over the course of four papers co-authored with Professor David Kaserman from 1978 to 1988. Blair and Kaserman’s first paper, Vertical Integration, Tying, and Antitrust Policy, contained mathematical proofs that vertical integration and tying have equivalent effects under certain circumstances. These equivalent effects were shown both in terms of profits the company can earn and the social effects of the strategies. This finding was significant because the two strategies have been historically treated very differently under antitrust laws. Tying is per se illegal under the antitrust laws, although that rule has been softened over time in cases like Illinois Tool Works v. Independent Ink by limiting when the per se rule applies. Vertical integration, however, is handled under rule of reason. Blair argued that this means that managerial decisions will be biased towards vertical integration, even if it makes less sense from a business perspective, because there is less legal risk.

Blair and Kaserman’s second paper, Uncertainty and the Incentive for Vertical Integration, provided evidence that vertical integration is often procompetitive. The paper showed that most models for vertical integration didn’t account for preferences for risk aversion. Once risk was factored in, there were procompetitive explanations for vertical integration. Blair concludes that “Vertical integration, which allows risk to be borne by the firm or firms with the least aversion to it, results in increased output of the final good and a reduced expected price.”

Blair and Kaserman’s third paper, Vertical Control with Variable Proportions: Ownership Integration and Contractual Equivalents, expanded his original analysis to show that four forms of vertical conduct — vertical merger, tying, a two-part tariff, and a per-unit royalty on downstream sales — were economically equivalent. The paper begins by noting that both vertical integration and tying may have significant downsides in certain cases that make them unattractive for a company. Blair then introduces two contractual alternatives that can be more advantageous for a company in certain circumstances, and then proves that these strategies are also equivalent in that they will earn the same profits and have a similar social welfare impact. The first alternative is a per-unit fee, like one might expect in a patent license. The second alternative is a lump-sum fee for the opportunity to buy an input, this is analogous to a membership to Sam’s Club or Costco. Each strategy has its strengths and weaknesses, and Blair’s argument is that all should be treated equally under antitrust laws so that a manager may select the best vertical control option from a business perspective rather than a legal perspective.

Blair and Kaserman’s fourth paper, Vertical Integration, Tying, and Alternative Vertical Control Mechanisms, again demonstrates that five types of vertical control (Blair discusses two types of royalty payments this time) are economically equivalent. The paper also comments on the fact that, while attitudes at the time were changing, vertical controls were treated differently under the law and that this different treatment biased business decisions for arbitrary reasons. Blair cautions that this arbitrary decision-making results in the wasting of resources.

This final paper by Blair and Kaserman made the most cohesive argument for similar legal treatment for all of these vertical controls. Blair states that all five control mechanisms produce the same price and quantity of the final good, use the same amount of resources, and have the same distribution of profits. However, transaction costs unique to each control mechanism mean that some strategies will make more sense than others. Blair argues that there is “no principled basis for according different [antitrust] treatment to economic equivalents.” Blair believes this is an incoherent policy with real costs, because companies sometimes choose wasteful strategies to avoid the legal risks of violating the antitrust laws.

Blair’s work on vertical controls has been persuasive, and both case law and enforcers seem to be slowly adopting his views. Many current antitrust scholars believe Blair will ultimately be proven correct.

Competition

Some, if not all of society’s most useful innovations are the byproduct of competition. In fact, although it may sound counterintuitive, innovation often flourishes when an incumbent is threatened by a new entrant because the threat of losing users to the competition drives product improvement. The Internet and the products and companies it has enabled are no exception; companies need to constantly stay on their toes, as the next startup is ready to knock them down with a better product.